Beta (β)
Sensitivity of strategy returns to a benchmark; measures systematic (market) risk in backtesting.
Definition
Beta = Cov(R_strategy, R_benchmark) / Var(R_benchmark). It is the slope of the regression of strategy returns on benchmark returns. Beta > 1 means the strategy moves more than the market; beta < 1 means it moves less.
Why it matters for backtesting
- Market exposure: Shows how much of the strategy’s behavior is explained by the benchmark (e.g. equity index).
- Alpha isolation: Combined with alpha, helps separate market beta from skill (alpha).
- Allocation: In a multi-strategy portfolio, betas help understand aggregate market exposure.
Limitations
- Single-factor; real returns may depend on multiple factors.
- Unstable over time; rolling beta can change in different regimes.
- Sensitive to the choice of benchmark and the estimation window.
Linked concepts
Alpha, Sharpe ratio, factor exposure, correlation.